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Wednesday, April 15, 2015

When Government Pre-Fills Income Tax Returns

[In commemoration of US federal income taxes being due today, April 15, here's a repeat of a post from April 15, 2014, on the subject of government filling out your taxes for you.]

As Americans hit that annual April 15 deadline for filing income tax returns, they may wish to contemplate how it's done in Denmark. Since 2008, in Denmark the government sends you a tax assessment notice: that is, either the refund you can receive or the amount you owe. It includes an on-line link to a website where you can look to see how the government calculated your taxes. If the underlying information about your financial situation is incorrect, you remain responsible for correcting it. But if you are OK with the calculation, as about 80% of Danish taxpayers are, you send a confirmation note, and either send off a check or wait to receive one.

This is called a "pre-filled" tax return. As discussed in OECD report Tax Administration 2013: Comparative Information on OECD and Other Advanced and Emerging Economies: "One of the more significant developments in tax return process design and the use of technology by revenue bodies over the last decade or so concerns the emergence of systems of pre-filled tax returns for the PIT [personal income tax]." After all, most high-income governments already have data from employers on wages paid and taxes withheld, as well as data from financial institutions on interest paid. For a considerable number of taxpayers, that's pretty much all the third-party information that's needed to calculate their taxes. The OECD reports:

"Seven revenue bodies (i.e. Chile, Denmark, Finland, Malta, New Zealand, Norway, and Sweden) provide a capability that is able to generate at year-end a fully completed tax return (or its equivalent) in electronic and/or paper form for the majority of taxpayers required to file tax returns while three bodies (i.e. Singapore, South Africa, Spain, and Turkey) achieved this outcome in 2011 for between 30-50% of their personal taxpayers. [And yes, I count four countries in this category, not three, but so it goes.] In addition to the countries mentioned, substantial use of pre-filling to partially complete tax returns was reported by seven other revenue bodies -- Australia, Estonia, France, Hong Kong, Iceland, Italy, Lithuania, and Portugal. [And yes, I count eight countries in this category, not seven, but so it goes.] Overall, almost half of surveyed revenue bodies reported some use of prefilling ..."

"Around two-thirds of taxpayers take only the standard deduction and do not itemize. Frequently, all of their income is solely from wages from one employer and interest income from one bank. For almost all of these people, the IRS already receives information about each of their sources of income directly from their employers and banks. The IRS then asks these same people to spend time gathering documents and filling out tax forms, or to spend money paying tax preparers to do it. In essence, these taxpayers are just copying into a tax return information that the IRS already receives independently. The Simple Return would have the IRS take the information about income directly from the employers and banks and, if the person's tax status were simple enough, send that taxpayer a return prefilled with the information. The program would be voluntary. Anyone who preferred to fill out his own tax form, or to pay a tax preparer to do it, would just throw the Simple Return away and file his taxes the way he does now. For the millions of taxpayers who could use the Simple Return, however, filing a tax return would entail nothing more than checking the numbers, signing the return, and then either sending a check or getting a refund. ... The Simple Return might apply to as many as 40 percent of Americans, for whom it could save up to 225 million hours of time and more than $2 billion a year in tax preparation fees. Converting the time savings into a monetary value by multiplying the hours saved by the wage rates of typical taxpayers, the Simple Return system would be the equivalent of reducing the tax burden for this group by about $44 billion over ten years."

Most of this benefit would flow to those with lower income levels. The IRS would save money, too, from not having to deal with as many incomplete, erroneous, or nonexistent forms.

For the U.S., the main practical difficulty that prevents a move to pre-filling is that with present arrangements, the IRS doesn't get the information about wages and interest payments from the previous year quickly enough to prefill income tax forms, send them out, and get answers back from people by the traditional April 15 timeline. The 2013 report of the National Taxpayer Advocate has some discussion related to these issues in Section 5 of Volume 2. The report does not recommend that the IRS develop pre-filled returns. But it does advocate the expansion of "upfront matching," which means that the IRS should develop a capability to tell taxpayers in advance, before they file their return, about what their parties are reporting to the IRS about wages, interest, and even matters like mortgage interest or state and local taxes paid. If taxpayers could use this information when filling out their taxes in the first place, then at a minimum, the number of errors in tax returns could be substantially reduced. And for those with the simplest kinds of tax returns, the cost and paperwork burden of doing their taxes could be substantially reduced.